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Saturday, January 1, 2000

How to Sink a Car Ferry

Government Subsidies Lead to Regulatory Nightmares

I recently had the opportunity to travel on a rare form of transportation—one that receives no government subsidies. The S.S. Badger, a ferry operated by the Lake Michigan Carferry Service, makes twice daily trips between Ludington, Michigan, and Manitowoc, Wisconsin, from mid-May to mid- October, carrying up to 180 automobiles and 620 passengers. For only $81, I was able to avoid driving through Chicago and spent the four-hour trip relaxing on a lounge chair on deck. I also had the chance to enjoy a movie, eat, shop, or visit a museum on board. Staterooms are available.

Ships began regularly carrying freight across Lake Michigan in 1875. The first car ferry, the Ann Arbor No. 1, began service in November 1892 between Kewaunee, Wisconsin, and Frankfort, Michigan, ferrying railroad cars across the lake to eliminate transferring cargo between trains and boats at each end. By the 1950s car ferries had expanded to carry automobiles and passengers as well as train cars. In 1955, the peak year for the ferries, the Chesapeake & Ohio (C&O) Railway’s seven car ferries carried 205,000 passengers, 71,000 automobiles, and 204,460 freight cars on 6,986 crossings among multiple Lake Michigan ports.

During that same time, the Ann Arbor Railroad was also operating five car ferries between Frankfort, Michigan, and four other lake ports. Although thousands of people crossed the lake on the not-particularly-comfortable ships, the railroads kept their emphasis on year-round boxcar transport, and passenger amenities like scheduled departures and food service were few. Rail-traffic demand for ferry service was declining, however. By the 1960s diesel train engines could pull 150 rail cars at 50 miles an hour around the rail bypass of Chicago with a crew of five or six, while a ferry, with its crew of 50, could carry only 20 freight cars at a time.

Railroads were heavily regulated by the federal government, so they could not simply stop uneconomical services. With the railroads losing millions of dollars a year on the ferries, the 1970s saw repeated attempts to secure Interstate Commerce Commission’s (ICC) permission to abandon service.

The Chessie System (the C&O’s successor) finally got out of the ferry business by turning over its three remaining ferries to a company formed by a Ludington businessman, the Michigan-Wisconsin Transportation Co. (MWT), in 1983. In a measure of how desperate the railroad was to shed its regulatory burden, it gave the MWT its last three ferries, which had a tremendous scrap value, for three dollars plus the MWT’s agreement to assume the Chessie’s federally mandated obligation to pay the ferry workers for six years even if the boats did not sail at all.

The MWT continued to operate the car-ferry service year-round as a combined freight and passenger operation, as it was required to do as a railroad under ICC rules. Even so, 80 percent of its revenue came from the summer tourist trade and only 20 percent from the year-round freight business. The failure to get out of the railroad business doomed the MWT. It ceased operation in November 1990 and filed for bankruptcy.

New Beginnings

When he learned that the MWT was planning to cease operations, local entrepreneur Charles Conrad stepped in to save the ferry. Conrad’s father, James, had spent 35 years working for Pere Marquette Railway, mostly as chief ferry engineer. “I spent a lot of my time with him crossing the lake,” Conrad told an interviewer in 1992. “Those ferries were a big part of my childhood.”

After a few years working on the ferries Conrad went on to a successful career as an entrepreneur. In 1962 he started Thermotron Industries, a maker of test chambers for everything from electronic circuitry to airplanes, with $1,000 and just one employee (himself). When he retired 18 years later, it had 550 employees and $18 million in annual sales. Conrad sold the company for an estimated $7.5 million.

Finding retirement not exciting enough, Conrad formed a company to restart the ferry service as a passenger and automobile service. He negotiated a deal with the MWT to buy the three ferries. A few months before the scheduled launch of the new service the MWT declared bankruptcy, however, and the bankruptcy court blocked the deal, ruling that open bids were required. Despite the possibility he would not get to buy the ships, Conrad invested another $1 million in renovating the S.S. Badger to ensure that he would not miss the scheduled launch date if he got the ships. Ultimately Conrad prevailed in the auction, paying $500,000 for the ferries and investing $1.5 million on improvements to launch the service with the Badger.

For the first year of service, Conrad hoped for 80,000 passengers-he got 115,000 and extended the sailing season to October 11 to meet the increased demand. The new service turned a profit its first year, and the surrounding area boomed. More recent estimates put the ferry’s economic impact at over $20 million each in Michigan and Wisconsin.

The Role of the Entrepreneur

The key to Conrad’s success was the transformation of the car ferry service from an extension of the railroad into a tourist oriented mini-cruise line. “This is really a whole new industry because now we are ferrying people instead of rail cars,” Conrad said in 1992. Although passenger traffic started in the 1940s, the railroads never marketed it to the public.

The focus on passengers brought a new emphasis on service as well. “We’re going to emulate Disneyland and Disney World as much as possible,” Conrad said. “We’re going to give customers the highest quality of professional services they’ll find anywhere.” A stickler for detail, he insisted on on-time departures and keeping the brochure racks full in the ticket office—a marked change from the railroad’s practice of refusing to run on a fixed schedule. He brought in experts to train his employees to ensure that everyone who got on board had a good experience. The crew was expanded to provide on-board entertainment—50 of the 60 crew members now concentrate on passenger services from the free “Badger Bingo” to puppet shows for children.

Much of the publicity surrounding the ferry’s new start under Conrad focused on his love for the Ludington area as a motive for his actions. “He didn’t buy the ferry to make money, and I think everyone ought to know that, if they don’t already,” Bruce Beda, a Milwaukee businessman and friend of Conrad’s, told an interviewer. “He’s running this ferry because he cares about helping his community.”

It’s possible the 74-year-old Conrad didn’t care about increasing his personal fortune through his investment in the car ferry, although I doubt he intended to throw his money away. It is impossible, however, that he didn’t care about making money. Unless the ferry made money it wouldn’t last.

Entrepreneurs succeed by filling a need others haven’t noticed. The railroads didn’t notice that their freight ferries had become passenger ferries, and they failed to adapt. The railroad union didn’t notice that unprofitable operations meant eventual closure. But Charles Conrad saw what others did not and created a profitable enterprise in a single year where others had lost millions for decades. His idea produced a legacy of a profitable car ferry, something that will continue to benefit the economies of Ludington and Manitowoc, and tourists like me, for years to come.

Conrad sold the ferry business to some of its executives in fall 1994 and died in February 1995.

His entrepreneurial skills and interest were obviously critical to the revival of the car ferry. But just as important was the federal government’s and the state of Michigan’s willingness to get out of the way of the transformation of the railroad car ferry into a passenger-oriented seasonal service. The ICC allowed the service to be classified as a passenger ship instead of a railroad, eliminating the requirement that it run 12 months a year and carry freight trains. The state exempted coal-burning ferries from some air pollution requirements. The company also took advantage of a new state law to negotiate an agreement with the state so that the new company would not be responsible for its predecessors’ contamination of the dock site, an agreement critical to getting the service started.

Note the important difference between what Conrad and what the government brought to the project. Conrad supplied the capital, the know-how, and the idea. The government kept its hands off. It didn’t require uneconomic service. It didn’t burden the 1940s-built ship with 1990s air pollution regulations. It didn’t require the company to pay for the environmental sins of unrelated prior owners of the site. It didn’t subject the company to the burdensome regulations that governed railroads. Any of those things could have killed the project. What the state brought to the table was a willingness to refrain from destroying the project before it could start. Sadly, we live in a society where that happens all too infrequently.

Stormy Waters Ahead

Unfortunately, the hands-off approach may be changing. Inspired by the new company’s success, other Lake Michigan towns are looking to revive their car ferries. Instead of seeking entrepreneurs, however, they are turning to the federal and state governments for subsidies. Looking north to the Ludington-Manitowoc ferry, Milwaukee officials determined they should have a ferry too. Although they discussed service with the Lake Michigan Car-ferry twice, negotiations ultimately failed. The two sides differ sharply over the reasons for the failure. The Carferry charges that the city demanded hundreds of thousands of dollars in “landing fees” and refused to participate in marketing efforts. The city claims the Carferry demanded operating subsidies as the price of starting service and couldn’t deliver the type of service needed by the Milwaukee market.

Despite their failure to interest the only successful ferry operator in the area, Milwaukee officials pressed ahead. “It is kind of logical we should have it,” Milwaukee Mayor John Norquist said during a 1994 budget hearing on a request for $500,000 in city funds to study the idea.

Getting Milwaukee the ferry service politicians think it should have apparently takes quite a bit of government help: for starters, $80 million in loan guarantees from the U.S. Maritime Administration to build high-speed hovercraft and a $650,000 loan from the state of Michigan to the town of Muskegon for a dock. The loan guarantees are essentially a way for private entities to borrow on the government’s credit rating rather than their own; the guarantees can shave several percentage points off interest costs and allow longer-term financing than would otherwise be available from private investors. Of course, if the borrower goes bust, the taxpayers are left paying off the loan.

Local newspapers also quickly uncovered disturbing facts about Hydrolink, the company chosen by state officials to launch the new ferry service. Its only known investor, a Wisconsin neurosurgeon, has a less than confidence-inspiring past: two bankruptcy filings since 1990, and guilty pleas to nine counts each of false swearing, forgery, and filing fraudulent sales tax returns, and quite a few malpractice charges lodged against him with state regulators. (In a boost to public confidence, the company won’t disclose the identities of any of the other investors.)

The new ferry may yet run aground. One sign of trouble for a politically structured proposal is when politicians start distancing themselves from the opportunity to hand out tax dollars instead of lining up to do so. U.S. Representative Peter Hoekstra, whose district includes both Ludington and the proposed new ferry’s docking site, Muskegon, was one of the first to jump ship. Although he initially told the Grand Rapids Press that “it’s pretty typical” that congressmen are asked if they agree with loan guarantees for constituents, four days later he told Ludington officials that “I am not sure how much influence a congressman can have on an issue like this.”

State officials aren’t rushing to claim credit for their contributions either. Michigan Governor John Engler’s spokesman said the administration was merely approving projects based on voter-approved criteria. “We just determined: Does the project have economic development potential? And is it good for the environment and does it clean up the waterfront? We had to pick the best projects based on how they were written.” The state concedes it didn’t consider whether the project would compete with an existing business.

Michigan and Milwaukee officials have been engaged in a great deal of doubletalk to conceal the subsidies. The subsidized docks aren’t a subsidy because anyone could use them. The loan guarantees aren’t a subsidy because no money changes hands (until a default!). Ludington residents, however, have no doubts about what the state support and federal loan guarantees mean: “We’re not opposing high speed ferry service,” said William Kratz, executive director of the Mason County Economic Development Alliance. “What we’re opposing is the taxpayer subsidy of one private business versus an existing, nonsubsidized private business.” The existing ferry company also sees through the Engler administration’s obfuscation: “We do consider the grant to be a financial subsidy that gives potential competition a significant advantage.” All agree—subsidizing a competitor would be a good way to sink the private-sector success story, leaving the taxpayers holding the bag on Hydrolink’s loans.

The unfairness of subsidizing a competitor to an existing private business is sometimes obvious even to politicians. The logical answer is not to subsidize either. Not surprisingly, some local politicians had a different response. One Michigan state senator said that “If the state has made its decision to be in the subsidy business on this, there’s going to have to be parity for Ludington.”

Subsidizing both services isn’t even a second-best alternative. Not only could government subsidies lead to the same kind of regulatory nightmare that sank the railroads and their car ferries, but forcing unasked-for subsidies on the private firm wouldn’t level the playing field. The Lake Michigan Carferry Service is turning a profit without a subsidy. Hydrolink can’t even float a boat without subsidized loans. Even if equal dollar amounts of subsidies went to both, the value of the subsidies to Hydrolink would be much greater. The real choice should not be between one subsidy or two (or three or four…) It should be between one subsidy or none.

The Superiority of Private Enterprise

Even a quick look at the contrast between the Ludington ferry and the proposed Milwaukee ferry shows the superiority of the unsubsidized service. One ferry was started as a labor of love by a successful entrepreneur who invested more than $2 million dollars of his own money. The other is backed by city officials who stand to enhance their own standing and a convicted forger, subsidized by massive government loan guarantees and direct expenditures. One is the result of years of involvement in the local community and resulting insights into the local economy. The other is the result of a politician’s desire to get what is “kind of logical” implemented despite the lack of a private sector response. The difference between the market’s and government’s responses couldn’t be clearer.

The ferries were almost sunk for good once by government regulation of the railroads. Let’s hope that Michigan and federal officials come to their senses and remember how they helped save the Ludington ferry—by doing nothing.

  • Andrew P. Morriss is the D. Paul Jones, Jr. & Charlene A. Jones Chairholder in Law and Professor of Business at the University of Alabama. He is coeditor (with Roger E. Meiners and Pierre Desrochers) of Silent Spring at 50: The False Crises of Rachel Carson, forthcoming from the Cato Institute.